Active investing in Europe [Quarterly Perspectives] - J.P. Morgan Asset Management
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Active investing in Europe [Quarterly Perspectives]

Contributor Global Markets Insights Strategy Team

At the start of the year we saw five reasons for better growth in the eurozone: the fading impact of austerity, slow but steady reform, an improving credit cycle, a European Central Bank (ECB) willing to act, and a weaker euro. A few months later, economic momentum looks to be building in the region and the case for investing in Europe has solidified. However, economic growth remains uneven and many European equity markets have already performed very strongly this year. With a chance of pullback, investors should consider prioritising pockets of expansion and taking advantage of active managers who can find attractive investment opportunities.

  • Cyclical indicators not only gauge the growth of a region but can offer insights into the more promising sectors of the market. European monthly new car registrations are nearing their long-term average after a trough in 2013. This kind of monthly activity hasn’t been seen since 2010, which makes sense as the European car fleet is ageing. In Spain, the average vehicle age in 2013 was 11.3 years vs. 8.5 years in 2007, while in Italy, the average age was 8.8 years in 2005 and 10 years in 2011. In Germany, however, it was 8.0 years in 2007 vs. 8.8 in 20131.
  • Year-on-year retail sales growth has increased markedly, to 3.7% in January 2015, indicating that European consumers are spending more. This consumption can be partly attributed to the windfall savings from cheaper energy costs, and the generally low level of inflation, which has helped to produce faster real wage growth.
  • Countries that previously struggled to expand are showing healthy signs of growth – the Spanish and Irish Purchasing Managers’ Indices (PMIs) for manufacturing are in expansionary territory.


European equities are not as cheap as they once were. Price-to-earnings (P/E) ratios have risen since the start of 2015 as a result of equity prices moving ahead of corporate earnings. We see room for continued improvement in this market, but future returns will depend on earnings growth and investors would be advised to take a selective approach.

  • Certain sectors are poised to benefit from the strong eurozone consumer. The recent uptick in retail sales has led consumer-driven sectors to post higher returns, as shown in this chart. While consumer discretionary is more expensive that its long-term P/E average, it was the best performing sector in the first quarter of 2015.
  • Financials posted strong earnings in the fourth quarter of 2014 and have a low P/E ratio relative to other sectors. These companies are bellwethers: they will do badly if deflation becomes entrenched or the domestic recovery goes into reverse, but they have already benefited from the improving credit environment and stand to gain disproportionately if Europe’s recovery surprises on the upside.
  • Sectors that have returned more in recent months actually have smaller weights in the index. This means that active management is needed to gain increased exposure to better performing sectors, such as consumer discretionary, industrials, and materials.
  • As euro area interest rates move to extreme lows, income-orientated investors are likely to find the higher dividend yields offered by certain stocks increasingly attractive.
Investment implications

Investors looking to make the most of the improving European economy should take a strategic approach and consider active managers who will invest sector by sector and company by company. The parts of the equity market that are more sensitive to the economic cycle are likely to see strong revenue growth in an improving economic environment. The under-representation of these more growth-oriented sectors in the traditional broad stock market indices provides another reason to take an active approach. GDP growth is not a guarantee of earnings performance; as and when markets move higher, stock selection will be increasingly vital in a region that is now more expensive than its long-term average on many traditional valuation measures.

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